One of the biggest mistakes investors can make when trying to build a second income stream with dividend stocks is chasing yield.
Buying stocks just because they have a high dividend yield can be a disastrous strategy because, more often than not, a dividend yield far above the market average is a sign that payout isn’t sustainable. If the distribution is cut, the resulting capital loss can eliminate years of dividend income.
With that in mind, I’m going to look at two FTSE 100 dividend stocks that might not have the highest yields around, but have some of the safest distributions in the index, in my opinion.
Impressive track record The first company I’m going to profile is Bunzl (LSE: LON:BNZL). This distributor is, without a doubt, one of my favourite FTSE 100 companies. Over the past few decades, the business has gone from strength to strength, expanding steadily through a combination of acquisitions and organic growth.
The company lives well within its means while reinvesting a substantial portion of profits back into the business to drive growth. Net profit has grown at a compound annual rate of just under 10% per annum for the past decade, and net debt has remained relatively constant as a percentage of shareholder equity. It has bounced between around 80% and 100% during the past five years.
That might seem like a lot of debt from an asset perspective, but because the business is relatively asset-light, the figures are somewhat misleading.
From a cash-flow perspective, Bunzl’s debt metrics are much less concerning. Last year, the company generated around £450m in free cash flow from operations compared to net debt of £1.4bn. These figures imply Bunzl could pay off all of its creditors in three years.
The dividend cost Bunzl £152m last year, which gives the company plenty of headroom to increase the distribution in the years ahead. And that’s why I think this stock could be an excellent investment if you’re looking to build a second income stream. At the time of writing, the shares support a dividend yield of 2.5%.
Market leader The other dividend champion I think might be worth considering for an income portfolio is Croda (LSE: CRDA). This stock currently supports a dividend yield of just under 2%. But the payout is covered twice by earnings per share, which gives the company plenty of headroom to increase the distribution in the years ahead.
What’s more, Croda is one of the world’s leading producers of speciality chemicals, which tells me it’s unlikely to ever experience a sudden drop in earnings. Producing chemicals for products such as cosmetics is a specialist industry, where customers have to be sure their products are of the highest quality, so they don’t tend to change suppliers.
Croda has been able to capitalise on this. Net profit is up around 35% in five years and earning should continue to grow steadily for the foreseeable future. These qualities tell me Croda could be an excellent investment for your second income stream portfolio.
Rupert Hargreaves owns no share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
Motley Fool UK 2019